Saturday, March 22, 2008

Bernanke's plan is working

Here is a brief description of the current problem in the US financial system.

a. It started with the subprime mortgages, which saw high default rates

b. The value of the "asset backed securites" and the "collaterialised debt obligations" linked to these mortgages dropped significantly

c. The problem spread to the other sectors. Many "special investment vehicles" and hedge funds had been set up to use borrowed money, i.e. "leveraging", to invest in higher risk assets to earn a margin. These SIV and hedge funds could not refinance their borrowings, as the lenders got scared.

d. Investors starting to withdraw their money from hedge funds, SIV and the investment banks.

This led to the collapse of Bear Stearns. There was fear that they have to sell their illiquid assets at depressed prices, causing a collapse of the entire global financial system.

The US Fed, under the chairman Bernanke, came out with a plan to provide up a 6 months facility for investment banks to allow them to borrow from its "discount window" i.e. at the Fed discount rate, by pledging their illiquid assets.

Some experts believe that this plan is working and that the markets will stabilise and recover from now. This is expected to solve the "liquidity crunch". Let us hope that they are right!
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1 comment:

Anonymous said...

I suppose when the Federal Reserve also jump in the bandwagon to offer loans on illiquid and depreciating assets, they just dug an even deeper hole. If they are very rich, then this plan may buy them time to recovery. If not, this plan can only last a couple of months before it all collapse and all fall into an even deeper hole. What's more, they are using public money to bail out the rogue financial institutions.

Well, those who hasn't got out of the market in time, now it's a good time. It's not a matter of how to win more, it's a matter of how to lose less.

The right thing to do, in my opinion, is to keep cash - maybe in fixed deposit or t-bills for a year or two. You will see the bottom for more stocks, ETFs and funds then.

Cheers
R.

March 23, 2008 5:33 PM

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